The Absolute Convertible Arbitrage Fund (ARBIX) returned +1.21% in the third quarter of 2022. Year-to-date the fund has returned -2.43%.

Market conditions for almost all securities continued to be difficult in the third quarter of 2022. We were pleased to post a small gain in the quarter while most other bond strategies endured significant drawdowns. Credit spreads were relatively stable in the quarter which helped support convertible valuations as selective buyers, like ourselves, added to higher conviction credits. Average implied credit spreads for convertibles ended the quarter at almost 600 over. Equity volatility was a small headwind for convertibles as 30 day historical volatility for the Russell 2000 fell from 35 to 26. But the big factor that dominates all others continues to be the dramatic rise in interest rates in 2022 as the Fed battles inflation. During the third quarter of 2022 alone, the Fed raised the effective fed funds rate from 1.58% to 3.08% which caused continued pain in the treasury market as the 5 year treasury yield rose more than 100 basis points to 4.09%.

From an overall gross P&L perspective for the quarter, convertible bond price appreciation versus the underlying stock hedge had a positive impact of +61 basis points, while the interest rate hedge positively contributed +40 basis points, yield/carry +38 basis points, and trading +13 basis points. Convertible theoretical valuations overall ended the quarter 50 basis points below fair value on average. The convertible market has been repriced, reflecting the new environment for rates and credit spreads leading to significantly higher return expectations going forward, especially when compared to the start of 2022.

Higher interest rates going forward will help the convertible arbitrage trade in the years to come. While new issuance has been light for convertibles and all corporate bonds this year, when it inevitably returns, the new convertible deals will be priced to reflect the adjusted market environment of higher interest rates and wider credit spreads. This repricing means higher coupons and better overall terms for convertible arbitrage buyers in terms of lower premiums and heavier hedges. In addition, the dramatic rise in the fed funds rate greatly improves the rebates we receive on our stock short positions, which will reflect higher deltas on new deals. In sum, higher coupons, lower conversion premiums and higher stock loan rebates will significantly improve the static carry and expected return for convertible arbitrage in the years to come.

Nobody knows when the Fed will reach a point where it will feel comfortable in not raising the fed funds rate further. As of now, it seems evident we are not there yet as inflation data has not significantly improved. As we said in our second quarter commentary, we will continue to maintain a capital preservation mindset while waiting for the Fed to tame inflation. More importantly, we will remain highly focused on fundamental, bottom up credit research, company by company.

Timing a market bottom is not possible but it does not prevent us from carefully deploying capital and gradually adding to our favorite securities. We expect to continue to invest this way through 2022 and likely into 2023 as taming inflation could prove more difficult than the wishful thinking that seems all too common in the investor community. Moreover, there could be some significant money moving away from poorly performing funds and therefore some risk of forced redemption selling. In summary, without knowing how rough things will get nor for how long, we will continue to preserve capital, stay liquid and gradually put new money to work in an environment where the expected return expectations for convertible arbitrage have greatly improved.

(Definitions, supporting data and risk disclosure below)

government regulations, differences in accounting standards and other factors. Investments in emerging markets involve even greater risks. Small, mid and large cap stocks are subject to substantial risks such as market, business, size volatility, management experience, product diversification, financial resource, competitive strength, liquidity, and potential to fall out of favor that may cause their prices to fluctuate over time, sometimes rapidly and unpredictably. The Fund is actively managed and may experience high turnover. This may cause higher fees, expenses and taxes, which could detract from Fund performance.

These views are subject to change at any time based on market and other conditions, and Absolute Investment Advisers disclaims any responsibility to update such views. No forecasts can be guaranteed. These views may not be relied upon as investment advice or as an indication of trading intent on behalf of any Absolute Investment Advised investment product.

Investors should carefully consider the Fund’s investments objectives, risks, charges and expenses before investing. This and other information is in the prospectus, a copy of which may be obtained by calling (888) 992-2765 or visiting the Fund’s web site: www.absoluteadvisers.com. Please read the prospectus carefully before you invest.